Saturday, May 21, 2011

Growth Stock: No Release but the Grave

For twenty year or so now, I've taught the "Gordon Growth Model" of valuing stocks, to be used when earnings are retained and reinvested. It's stylized and simplified, sure, but it's supposed to focus on the mind on the skill (or incompetence) of managers in making reinvestment decisions. I think it's an important point to make but I don't think I've ever done a good job of making it plausible or even interesting to students who, to be fair, are pretty much beginners at this stuff. On reflection, I need to present it more like it is: as a blood sport, a bearbaiting in which the bear can win.

If I choose this route, I could worse than deploy the account furnished by Robert Boyd in Fatal Risk, his account of the rise of American International Group and its formerly legendary CEO, Maurice "Hank" Greenberg. Per Boyd, the lesson of AIG/Greenberg is that the category of "growth stock" is one of the trickiest in which a corporate manager can find himself:

In the 2st century, being the CEO of a growth stock was a designation unlike any other in the capital markets. Your stock stayed well bid when others in your sector sold off; the bad news or ill omens that forced the stock prices of your bitter rivals ever lower affected you half so much. Even if a full-bore contraction took place when

The flip side of being a growth stock was being a company that had engendered deep-seated investor disappointment. Growth stock investors didn't rotate out of a stock, they abandoned it, resulting in the unrestrained selling of shares--it took very little time in globally integrated securities markets to go from overvalued to undervalued--and a board that would likely decide that a change of leadership was needed. The growth stock CEOs club was not one that you could voluntarily leave, save for feet first.

All this may be true of any company but it takes on special piquancy in the case of insurance:

The details of running an insurance company--reserves against clams, claims liquidity, underwriting discipline, an aversion to risk--all come into conflict with the pressures of growth stock status. An insurance man at his core, Greenberg did not seek the easy path to goosing earnings in the short term, by underreserving and writing insurance coverage on anything and everything in a grab for premiums. He chose growth ...

And as Boyd shows, the thing about growth is that it works until it doesn't work any more:

Greenberg's situation in 2000-2001 left him little cover. The company was so big and in so many sectors of the market that there was no "natural" target left for them. So, in a move that was rare for him, he did what other CEOs did in this dilemma: he bought other companies simply because that's where the growth was.

You know the rest of the story: once growth topped out, the marketing superstars made a play for accounting trickery--this on the heels of the Enron debacle, when regulators for once found themselves in a mood to try to prove they offered some relevance to the world. It was Greenberg, once the most legendary of CEOs, who found the gods abandoning him, like Antony after Actium; it was he who found himself departing feet first. And still later, of course, came the hard lesson that left us all on the hook for ($182 billion) ($50 billion) (whatever). Greenberg has the consolation of saying (if he wants to) that he wasn't on board at the time of the bailout. Still, there's an implacable logic here that is built into the growth model: you start out chasing the bear, and one day the bear starts chasing you.

2 comments:

Anonymous
said...

a typo here "clams" for "claims" reminded me -- i was in kroger's in huntsville, alabama yesterday and although it has a mile of canned soups i couldn't find "manhattan" clam chowder -- only New England clam chowder. i dont like New England, i like manhattan. it's been years since i've been able to find one -- when i did i would also buy a can of clams and add them to the soup so that there would be discernible clam in it. do insurance companies still call "profits" "reserves."?